Protecting EBITDA: What business leaders should know about insurance and risk

For many organizations, earnings before interest, taxes, depreciation and amortization, commonly known as EBITDA, is an important measure of operating performance. It may also factor into lending conversations, valuation assessments and long-term growth planning.

Organizations work hard to grow revenue, improve margins and increase earnings. Yet a significant disruption can quickly place that progress at risk. While most organizations have a strategy for growing earnings, fewer have considered how they would protect those earnings from an unexpected event.

A cyber incident may interrupt cash flow and produce unplanned response costs. A fire can halt operations while fixed expenses continue. The insolvency of a major customer can turn an expected payment into a bad debt loss. Although each scenario originates in a different part of the business, they can still affect financial performance.

Insurance cannot create earnings, improve margins or prevent a disruption. What it can do is help protect the financial progress an organization has already made by limiting the effect of certain covered losses when earnings and cash flow come under pressure.

That is why insurance should not be viewed solely as an annual purchasing exercise. A broader discussion considers an organization’s total cost of risk (TCOR), including insurance premiums, retained risk and the potential financial impact of uninsured or underinsured losses and business disruptions.

How can a major disruption affect EBITDA?

The financial impact of an unexpected disruption often extends well beyond the initial event.

Consider a company that experiences a ransomware attack. IT systems are taken offline, disrupting operations and limiting the organization’s ability to serve customers. Revenue may decline during the interruption, but payroll, debt payments and other fixed expenses often continue. The organization may also incur costs related to forensic investigations, legal support and system recovery. The result can be pressure from multiple directions at once: reduced revenue, increased expenses and added strain on cash flow.

In this hypothetical example, a $1.5 million uninsured loss represents approximately one-quarter of annual EBITDA. The financial impact could be greater if the event also causes lost sales, recovery expenses, customer attrition or additional borrowing needs.

Three insurance strategies business leaders should evaluate

No insurance policy protects EBITDA directly. Instead, individual coverages may respond to specific events that impact revenue, create expenses or reduce cash flow. Business income insurance, trade credit insurance and cyber liability insurance each address a different financial exposure that organizations may want to evaluate.

Business income insurance

A property loss can create two separate financial challenges: the cost of repairing or replacing covered assets and the loss of income while operations recover.

Business income insurance is designed to help address the second challenge when a covered loss interrupts normal operations. Depending on the policy, coverage may help replace lost income, support certain continuing expenses and address additional costs incurred to reduce downtime.

The exposure is not always tied to how quickly facilities or equipment can be repaired. Production may take time to return to capacity, customer demand may recover more slowly than expected and revenue may lag behind operational recovery. A prolonged interruption may also affect liquidity, an organization’s ability to meet debt obligations and its ability to fund planned investments.

Trade credit insurance

For many organizations, accounts receivable represents one of the largest assets on the balance sheet. When a major customer becomes insolvent or fails to pay, the impact can extend beyond a missed payment. A significant bad debt loss can affect cash flow projections, reduce available liquidity and create pressure on operating performance.

Trade credit insurance may help protect covered receivables from certain nonpayment risks. Evaluating this exposure can also help organizations better understand customer concentration risk and the potential financial impact of a major default.

Cyber liability insurance

Cyber incidents can create expenses at the same time they disrupt an organization’s ability to generate revenue. Systems may need to be restored, operations may be interrupted and organizations may incur costs related to legal support, forensic investigations and recovery efforts.

Cyber liability insurance may help address certain response expenses, business interruption losses and third-party liabilities arising from a covered event. For financial leaders, cyber risk is not solely a technology concern. It’s also an operational and financial exposure.

Does your coverage reflect your financial priorities?

An insurance review can easily become a discussion about premiums, deductibles and limits. But those numbers have little meaning without understanding the financial risk behind them.

If a major customer defaulted tomorrow, how would it affect cash flow? If operations were interrupted for several weeks, how long could the organization continue meeting payroll, debt obligations and other fixed expenses? If a cyber event disrupted critical IT systems, how much liquidity would be needed to respond and recover?

These questions help translate insurance decisions into financial decisions. A higher deductible may reduce premium costs, but it also increases the portion of a covered loss the organization must fund. Similarly, a policy limit may appear adequate until it is measured against the revenue, expenses or receivables actually at risk.

The lowest premium does not necessarily create the lowest total cost of risk. A lower priced insurance program may provide less protection or require the organization to retain more risk. If that retained exposure exceeds the organization’s available liquidity or ability to absorb a loss, the initial premium savings could be outweighed by the financial consequences of the event.

The goal is not automatically to purchase more insurance. It is to understand which losses the organization has the financial capacity to retain and which could threaten broader business objectives.

Review your EBITDA protection strategy

Growing EBITDA requires deliberate financial and operating decisions. That begins with understanding the organization’s total cost of risk, how much financial exposure it can absorb and which events could compromise liquidity, growth plans or business objectives.

Huntington Insurance can help your organization evaluate financial exposures, review whether current coverage aligns with its risk tolerance and make more informed decisions about retaining and transferring risk.

Connect with a Huntington Insurance advisor to discuss your organization’s insurance and risk management needs.